Reflections on the reflective loss principle and the recent decision in Sevilleja v Marex Financial Ltd

The decision

Creditors of companies and, possibly, many more potential claimants have cause to celebrate a quiet revolution in law as the Supreme Court overturns 20 years of established law prohibiting creditors making a claim against a third party when the insolvent company has the same claim, often referred to as the rule prohibiting “reflective loss”. The decision in Sevilleja v Marex Finance Ltd (Marex) [2020] UKSC 31 represents a substantial recasting, or some may say elucidation, of the rule on “reflective loss” and reverses the Court of Appeal’s earlier decision in this case, as well as some 20 years of similar decisions. So what is the “reflective loss” principle?  And what is the import of this recent decision?

Reflective loss principle 

The rule on reflective loss was established in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 and expanded upon in Johnson v Gore Wood & Co [2002] 2 AC 1.

The principle prevents shareholders from commencing proceedings against third parties where the shareholders’ losses are a consequence of loss suffered by the company (e.g. a diminution in the value of the shareholding or distributions), caused by the third parties’ conduct.  Under English company law, the shareholders’ losses are not deemed to be separate and distinct from the losses of the company – they are a reflection of the loss suffered by the company – thus any resultant claim lies with the company only.  One of the issues underpinning the rule is a concern about double recovery.  The rule operates even where no proceedings are brought by the company for the loss suffered, meaning that in those particular circumstances, the shareholders’ loss is irrecoverable, because shareholders are barred from making a personal claim.

It has been argued by some that the principle of reflective loss had been expanded too far and, if applied in the Marex case, would have caused injustice.  Lord Sales considered in his judgment whether the reflective loss principle should prohibit claims by shareholders at all.  Is this case a turning point for shareholders going forward?

The facts

Mr Sevilleja owned and controlled two companies incorporated in the British Virgin Islands.  Marex obtained judgment against both companies in the sum of US$5.5 million, plus costs in July 2013.  Thereafter, Mr Sevilleja procured the offshore transfer of over US$9.5 million from the companies’ London accounts into his personal control.  By the end of August 2013, the companies’ assets were so depleted that Marex could not obtain payment of its judgment and costs. In December 2013, Mr Sevilleja placed both companies into liquidation.

Marex subsequently brought a claim against Mr Sevilleja, claiming that he was liable in tort for inducing or procuring the companies to act in wrongful violation of the judgment (and Marex’s rights thereunder), and/or for intentionally causing loss to Marex by unlawful means.  Mr Sevilleja contended that Marex’s claim was precluded due to the reflective loss principle. The Court of Appeal agreed that the reflective loss principle prevented Marex’s claim, as it applied to creditors of a company (irrespective of whether they were shareholders or not).  The Supreme Court held to the contrary.

The Supreme Court’s decision

The Supreme Court allowed Marex’s appeal, finding that the reflective loss principle does not preclude claims by creditors of a company.

The judgment discussed in detail whether this principle should remain in place for claims by shareholders. The majority of the Judges held that the reflective loss principle as set out in Prudential remains good law for shareholders.  Claims brought by shareholders relating to losses they have suffered in their capacity as shareholders, such as a diminution in share value or in distributions remain barred. In these cases, the company remains the true claimant.  Claims by shareholders in another capacity however, (e.g. as a creditor or employee), even where the company has a claim for substantially similar loss, should be recoverable in principle (subject to double recovery being prevented).

The minority judgment of Lord Sales went further and favoured an approach which would permit shareholders’ claims on the basis that they are not the same as the company’s losses, with concerns about double recovery and concurrent claims being dealt with by the court through other means.

Conclusions

The Supreme Court’s decision has clarified and circumscribed the parameters of the reflective loss rule, which has produced some perplexing decisions in the past. Indeed the Supreme Court referred to a number of earlier cases which it considers were wrongly decided.  The decision is tantalising news for creditors of insolvent companies who may now seek to break ranks, and abandon the collective remedy through liquidation processes in digging out individual claims against errant directors.

The minority decision of Lord Sales is likely to provide fertile grounds for debate on the subject and to open the door for shareholders to argue that they can make claims in their own right.  What is clear from this decision is that the reflective loss principle does not extend so far as to prohibit claims by parties other than shareholders (e.g. creditors and employees) and leaves scope for shareholders to argue that they can make a personal claim.

Should you have any questions arising from this blog or wish to discuss your own potential claim, please contact Zahira Hussain or any member of the Litigation & Dispute Resolution team or the Restructuring and Insolvency team.

 

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